TheCorporateCounsel.net

Last week, Vice Chancellor Zurn of the Delaware Court of Chancery determined that the shareholder derivative litigation against Boeing’s board of directors could proceed, based on allegations that the directors breached their duty of loyalty by not making a good faith effort to implement an oversight system and monitor it. The court dismissed the shareholders’ claims against the officers and the board for compensation decisions.

In light of the tragic loss of life that formed the basis for this lawsuit, the allegations here about the shortcomings in director decision-making are troubling, and that may have affected the opinion. The court noted that:

– Meeting minutes didn’t indicate rigorous director discussions of safety issues

– No board committee was charged with direct responsibility to monitor safety

– The board didn’t direct management to provide regular safety updates – it “passively” received updates at management’s discretion

– The Board publicly lied about whether & how it monitored the 737 MAX’s safety in order to preserve its reputation

Based on this, VC Zurn held that the board came up short on both Caremark prongs: it failed to establish a monitoring system and failed to respond to red flags. She also found that the plaintiffs adequately alleged scienter. Alarmingly for companies and their advisors, VC Zurn determined that the board’s remedial step of creating a safety committee after the crashes was evidence that, before the crashes, it had no oversight process at all – and knew it.

For 25 years, it was notoriously difficult for a Caremark claim to survive a motion to dismiss, even though the court has to accept the plaintiffs’ allegations as true at that stage of litigation. VC Zurn even acknowledged in her opinion that it’s extremely difficult to plead an oversight failure. Yet, a series of Caremark claims have proceeded past the motion to dismiss stage in just the past couple of years. As this Wachtell Lipton memo notes, that’s a big deal for the company and the board:

The company’s directors now face the prospect of intrusive document discovery, extensive depositions, and either an expensive settlement or a trial to defend the effectiveness of their oversight.

UCLA’s Stephen Bainbridge blogged that this case is another sign that Caremark claims are getting easier. He notes that the court took a much closer – and less favorable – look at board decisions than what you’d expect. Yet, as Kevin LaCroix blogged, the crashes at issue here “dramatically highlighted the critical importance of safety issues for Boeing.” And – hopefully – these types of events are rare. So, it’s too early to declare that every duty-of-oversight claim will proceed to the merits. But Kevin notes:

All of that said, I do think the recent spate of breach of the duty of oversight cases will encourage plaintiffs to pursue these kinds of claims and to include claims of breach of the duty of oversight in cases in which companies have experienced significant adverse circumstances in important operations. I suspect we are going to see an increase of claims of this type.

That makes it all the more important for other boards to review their risk management processes right now. Helpful steps could be:

– Document the board’s oversight of enterprise risk management, its process for asking questions & reviewing risks, and its evaluation of which functions are “mission critical”

– Ensure the board has a robust oversight process for key functions that create significant risk – and consider forming a dedicated board committee

– Document regular risk reporting to the committee & board, directors’ rigorous discussions & questions about risks, and board-directed risk reports

– Liz Dunshee